Property Transactions:

1
Chapter 12

• Property Transactions
• Nontaxable Exchanges

2
Nontaxable Transactions(slide 1 of 4)

• In a nontaxable transaction, realized gain or
  loss is not currently recognized
• Recognition is postponed to a future date (via a
  carryover basis) rather than eliminated

3
Nontaxable Transactions(slide 2 of 4)

• In a tax-free transaction, nonrecognition of
  realized gains is permanent

4
Nontaxable Transactions(slide 3 of 4)

• Holding period for new asset
• The holding period of the asset surrendered in a
  nontaxable transaction carries over to the new
  asset acquired

5
Nontaxable Transactions(slide 4 of 4)

• Depreciation recapture
• Potential recapture from the asset surrendered
  carries over to the new asset acquired in the
  transaction

6
Like-Kind Exchanges(slide 1 of 9)

• Section 1031 requires nontaxable treatment for
  gain and losses when
• Form of transaction is an exchange
• Assets involved are used in trade or business or
  held for production of income
• However, inventory, securities, and partnership
  interests do not qualify
• Asset exchanged must be like-kind in nature or
  character as replacement property

7
Like-Kind Exchanges(slide 2 of 9)

• Like-kind property defined
• Interpreted very broadly
• Real estate for real estate
• Improved for unimproved realty qualifies
• U.S. realty for foreign realty does not qualify
• Tangible personalty for tangible personalty
• Must be within the same general business asset or
  product class
• Livestock of different sexes do not qualify

8
Like-Kind Exchanges(slide 3 of 9)

• Boot
• Any property involved in the exchange that is not
  like-kind property is boot
• The receipt of boot causes gain recognition equal
  to the lesser of boot (FMV) or gain realized
• No loss is recognized even when boot is received

9
Like-Kind Exchanges(slide 4 of 9)

• Boot
• The transferor of boot property may recognize
  gain or loss on that property
• Treat as if boot property sold for its FMV

10
Like-Kind Exchanges(slide 5 of 9)

• Liabilities as boot
• If a transferor in a like-kind exchange is
  relieved of a liability as part of the exchange,
  the debt relief equals boot
• Boot from debt relief is reduced to the extent of
  any debt assumed by the taxpayer in the exchange

11
Like-Kind Exchanges(slide 6 of 9)

• Basis in like-kind asset received
• FMV of new asset
• - Gain not recognized
• Loss not recognized
• Basis in new asset
• Basis in boot received is FMV of property

12
Like-Kind Exchanges(slide 7 of 9)

• Basis in like-kind property using Code approach
• Adjusted basis of like-kind asset given
• Adjusted basis of boot given
• Gain recognized
• - FMV of boot received
• - Loss recognized
• Basis in new asset

13
Like-Kind Exchanges(slide 8 of 9)

• Example of an exchange with boot
• Zak and Vira exchange equipment of same general
  business asset class
• Zak Basis 25,000 FMV 40,000
• Vira Basis 20,000 FMV 30,000
• Vira also gives securities Basis 7,000 FMV
  10,000

14
Like-Kind Exchanges(slide 9 of 9)

• Example of an exchange with boot (contd)
• Zak has a 10,000 recognized gain 25,000 basis
  in the equipment, 10,000 in the securities
• Vira has a 3,000 recognized gain 30,000 basis
  in equipment

15
Involuntary Conversions(slide 1 of 13)

• Involuntary conversion defined
• The destruction, theft, seizure, condemnation, or
  sale or exchange under threat of condemnation of
  property
• A voluntary act by taxpayer is not an involuntary
  conversion

16
Involuntary Conversions(slide 2 of 13)

• Section 1033 permits (i.e., not mandatory)
  nontaxable treatment of gains if the following
  requirements are met
• Amount of reinvestment in replacement property
  must equal or exceed the amount realized

17
Involuntary Conversions(slide 3of 13)

• Section 1033 requirements
• Replacement property must be similar in function
  or use as involuntarily converted property
• Replacement property must be acquired within a
  specified time period

18
Involuntary Conversions(slide 4 of 13)

• Replacement property defined
• Must be similar in use or function as the
  converted property
• Definition is interpreted very narrowly and
  differently for owner-investor than for
  owner-user
• For business or investment real estate that is
  condemned, replacement property has same meaning
  as for like-kind exchanges

19
Involuntary Conversions(slide 5 of 13)

• Taxpayer use test (owner-investor)
• The property must have the same use to the owner
  as the converted property
• Example Rental apartment building can be
  replaced with a rental office building because
  both have same use to owner (the production of
  rental income)

20
Involuntary Conversions(slide 6 of 13)

• Functional use test (owner-user)
• The property must have the same function to the
  owner as the converted property
• Example A passenger car is not replacement
  property for a delivery truck used in a trade or
  business because each has a different function to
  the owner-user

21
Involuntary Conversions(slide 7 of 13)

• Time period for replacement
• Replacement time period starts when involuntary
  conversion or threat of condemnation occurs
• Replacement time period ends 2 years (3 years for
  condemnation of realty) from the year-end of year
  that gain is realized

22
Involuntary Conversions(slide 8 of 13)

• Example of time period for replacement
• Taxpayers office is destroyed on November 4,
  1998
• Taxpayer receives insurance proceeds on February
  10, 1999 (realization)
• Taxpayer is a calendar-year taxpayer
• Taxpayers replacement period is from November 4,
  1998 to December 31, 2001

23
Involuntary Conversions(slide 9 of 13)

• Nonrecognition of gain Direct conversions (into
  replacement property)
• Involuntary conversion rules mandatory
• Basis and holding period in replacement property
  same as converted property

24
Involuntary Conversions(slide 10 of 13)

• Nonrecognition of gain Indirect conversions
• Involuntary conversion rules elective
• Gain recognized to extent amount realized
  (usually insurance proceeds) exceeds investment
  in replacement property

25
Involuntary Conversions(slide 11 of 13)

• Nonrecognition of gain Indirect conversions
• Basis in replacement property is its cost less
  deferred gain
• Holding period includes that of converted property

26
Involuntary Conversions(slide 12 of 13)

• Involuntary conversion rules do not apply to
  losses
• Loss related to business and production of income
  properties are recognized
• Personal casualty and theft losses are recognized
  (subject to 100 floor and 10 AGI limit)
  personal condemnation losses are not recognized

27
Involuntary Conversions(slide 13 of 13)

• Obtaining replacement property
• Generally the taxpayer must purchase the
  replacement property
• Indirect purchase may be allowed by purchasing
  80 control of a corporation owning qualifying
  replacement property.

28
Sale of Residence (1 of 4)

• Sec. 1034 (rollover of gain) is repealed

29
Sale of Residence (2 of 4)

• Sec. 121 (125,000) exclusion is modified to
  provide a new 250,000 (500,000 MFJ) exclusion
  of gain
• applies to sales after May 6, 1997
• generally, no more than every 2 years
• unless, sale due to employment or health
• then, exclusion is pro rated
• e.g. Gain of 50,000 realized, residence held
  only 11 months because of job transfer, MFJ can
  exclude the entire gain (500,000 x
  11/24229,167)

30
Sale of Residence (3 of 4)

• Sec. 121 (contd)
• property must have been owned for 2 of 5 years
  preceding disposition, and
• used as principal residence of taxpayer for at
  least two of those years
• Taxpayer has only one principal residence
• can be condominium, houseboat, house trailer
• if taxpayer owns multiple residences, taxpayer
  should occupy the residence that is most likely
  to be sold at a gain.

31
Sale of Residence (4 of 4)

• Sec. 121 (contd)
• for sales after May 6, 1997 and before August 5,
  1997, taxpayers must elect
• for sales after August 5, 1997, this provision
  applies unless taxpayer elects otherwise